The Ultimate Guide to Credit and Credit Score

Credit represents the ability of a borrower to obtain goods or services before payment, based on the trust that payment will be made in the future. A credit score is a number representing the risk which a borrower presents to a lender, or the likelihood that the borrower will be able to pay back a loan and have the responsibility to do so on time.

A quick glance at this single bit of information gives creditors all they feel they need to make judgments about whether you will repay a car loan, mortgage or credit card debt. Your score is a snapshot of your credit report, giving creditors instant clues about how you pay your bills, handled credit over the years, and even whether financial troubles have led you into the courts.

Credit scores for mortgage range from 300 (high risk borrowers) to 850 (low risk borrowers), though few scores ever reach these extremes. Although several different types of credit scoring exist, most lenders use scores developed by Fair Isaac & Company, Inc., better known as FICO scores.

What constitutes a credit score?

Credit scores are made up of several factors that are monitored in a borrower’s credit profile. The components of a FICO credit score are as follows:

35% - Payment history

30% - Current amount of debt

15% - Length of credit history

15% - Types of available credit

10% - New credit inquiries

While credit ratings do not include demographic factors such as gender, ethnicity, nationality, or marital status, they also do not consider other information that may be relevent to lenders such as income, savings, or down payment amount.

As expected, credit scores typically include both positive and negative information contained within credit report. While late payments will negatively impact a borrower’s credit, he or she may raise the credit score by starting or restarting a consistent payment record.

Scoring models may be based on more than the information in your credit report. When you are applying for a mortgage loan, for example, the system may consider the amount of your down payment, your total debt, and your income, among other things.

Improving your score significantly is likely to take some time, but it can be done. To improve your credit score under most systems, focus on paying your bills in a timely way, paying down any outstanding balances, and staying away from new debt.

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What is bad credit?

A person with bad credit is someone who has been unable to repay their loans, or keep up with their other financial obligations (such as utility bills or parking tickets). People with bad credit are only able to obtain loans with high interest rates or unattractive terms.

Bad credit can be repaired over time, if the cardholder or bill payer reestablishes a consistent and positive payment record.

What is good credit?

In order to achieve good credit, borrowers must not only be able to successfully manage all lines of credit and make consistent and timely payments, but also demonstrate their ability to use credit responsibly.

In other words, you cannot have a good credit score if you do not have any credit, meaning that all high credit scores must be built as the result of diligent payments and smart financial management.

In order to establish good credit, borrowers must apply for credit via credit cards, vehicle loans, or home mortgage loans. After being granted credit, borrowers will establish a credit limit, or the maximum amount of credit available to a particular borrower.

As a borrower proves himself responsible for managing loan funds by making payments on time and keeping credit card balances paid off, the credit limit increases. Though the credit limit will initially be quite small and larger credit transactions (such as home loans) will be difficult to acquire, over time the limit will grow and allow borrowers to make larger credit purchases.

What is required to establish credit?

In order to establish credit, a borrower must have at least one account on his or her credit report open for six months or more. In addition, at least one account must be updated within six months prior to receiving a credit score. This information is necessary to establish a reliable reputation and produce an accurate credit score. Borrowers who do not satisfy these criteria will need to begin to establish a credit history before planning to apply for a home mortgage.

How can I achieve a good credit score?

Making on-time payments is critical in obtaining a good credit score. Regardless of the amount of debt owed, a borrower’s credit will suffer for each late payment, and frequent delinquencies will require a long recovery. Additionally, keeping credit card balances to a minimum of 30% of the card’s maximum limit can vastly improve your credit. Furthermore, it is advisable not to close unused credit cards when attempting to improve your credit score, since these may actually strengthen credit scores with even infrequent use by extending your credit history.

Will checking my credit score lower my credit rating?

Due to recent policy changes, the negative repercussions associated with credit checks have been significantly diminished. Consumer initiated credit inquiries for mortgage or auto loans are discarded for scoring purposes for a full 30 days, after which multiple inquiries begin to accumulate as negative points. While all credit checks will appear on any give borrower’s credit report, only repeated inquiries over a prolonged amount of time will have detrimental effects to credit.

Reason Codes

Credit scores are always accompanied by a maximum of four reason codes. These codes help to explain the logic behind a borrower’s score by specifying the reasons in which a particular borrower did not receive a higher score. Reason codes also assist lenders in outlining the reasons why a borrower did not qualify for either a loan or low interest rates. Although these scores involve credit history, reason scores are not included by the Fair Credit Reporting Act and are not part of a borrower’s credit profile.

The Fair Credit Reporting Act

The Fair Credit Reporting Act (FCRA) is designed to help ensure that the Credit Reporting Agencies furnish businesses with correct and complete information to use when evaluating your application.

Your rights under the Fair Credit Reporting Act:

You have the right to receive a copy of your credit report. The copy of your report must contain all of the information in your file at the time of your request.

You have the right to know the name of anyone who received your credit report in the last year for most purposes or in the last two years for employment purposes.

Any company that denies your application must supply the name and address of the CRA they contacted, provided the denial was based on information given by the CRA.

You have the right to a free copy of your credit report when your application is denied because of information supplied by the CRA. Your request must be made within 60 days of receiving your denial notice.

If you contest the completeness or accuracy of information in your report, you should file a dispute with the CRA and with the company that furnished the information to the CRA. Both the CRA and the furnisher of information are legally obligated to reinvestigate your dispute.

You have a right to add a summary explanation to your credit report if your dispute is not resolved to your satisfaction.

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About The Author:

Liz Clinger

Liz Clinger has multiple years of experience in the mortgage and real estate industries as an internet marketing professional... more